Is There a Shareholder Oppression Remedy in California?

by Gerald P. (“Jerry”) Burleson, Esq., Member of the California Bar and Robert Kaufman, J.D., University of San Diego School of Law, and July, 2012 California Bar Examinee

“Shareholder oppression” is a term that was coined in various court decisions outside of California. It describes a legal remedy that ought to be available to minority shareholders of non-public corporations who find themselves “squeezed out” of any realistic benefit from ownership of their shares in the corporation. While a dissatisfied shareholder in a public corporation can always sell her shares in the market, such an exit strategy is not usually available to a shareholder in a private company. The decisions of courts throughout the country reveal that shareholder oppression is discussed in at least two different contexts. First, the term is applied with remedial legislation adopted by a number of states, including California, that gives a court the discretion under limited circumstances to liquidate the corporation where necessary for the protection of the minority from “oppression,” “persistent unfairness,” or some other similar sounding but not very well defined wrong by the majority. Second, shareholder oppression is discussed in some court decisions as a separate remedy in tort available, in theory, to minority shareholders to seek damages from majority shareholders for their “oppressive” actions toward the minority. Such a separate tort remedy has not been widely recognized, however. The following is a discussion of the treatment by courts in some leading states of suits brought by minority shareholders for shareholder oppression.

The leading case cited by other courts in defining the term “shareholder oppression” is Gimple v. Bolstein, 477 N.Y.S.2d 1014 (1984). In that case, a minority shareholder brought suit for dissolution of a corporation under New York’s special circumstances corporate dissolution statute, which is designed to offer some protection to minority shareholders of non-public corporations who find themselves “frozen out” by those in control. The shareholders of the corporation in Gimple were third generation heirs of a family dairy business. The owner/shareholders had always participated actively in the management and daily operations of the business, and they had always been compensated in the form of salaries, benefits and perquisites; the company had never paid dividends and it did not conduct annual shareholder meetings. The plaintiff in Gimple had embezzled money from the company and was discharged as an employee ten years before bringing his lawsuit. Since his discharge, the plaintiff had been excluded from all management decisions, from access to corporate financial information and of course, from any return on his shares.

The New York special circumstances dissolution statute gives the court discretion to dissolve a corporation where those in control have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders or where the corporation’s property or assets are being looted or wasted by those in control. The statute gives no definition of the term “oppressive.” The court in Gimple surveyed decisions of other courts across the country construing similar statutes, including at least one California decision, and it found that there are two definitions in use by the courts that are not mutually exclusive: (1) The first defines “oppression” as a violation of the reasonable expectations of the founders of the business, determined by “an examination into the spoken and unspoken understanding upon which the founders relied when entering into the venture.” The court said that this definition ordinarily will only apply to the original participants in a close corporation, therefore it was inapplicable to the third generation owners in Gimple who inherited their shares of the family owned business. (2) The second definition in use by the courts describes “oppressive conduct” as “burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.” Id. at 1018. The court in Gimple described this second test as an alternative test to be used when the question of oppressiveness cannot be determined by applying the reasonable expectations of the parties. Under this second test, the court will consider whether the conduct complained about was “inherently oppressive.” The court stated that even where a minority shareholder is in the position of a stranger to the majority, they must still act with “probity and fair dealing toward the minority shareholders.” If the majority’s conduct becomes “burdensome, harsh and wrongful” they may be guilty of oppression and the corporation may be subject to dissolution.

Relying upon the second test, the court in Gimple found that the plaintiff’s discharge and subsequent exclusion from management was not oppressive since it was clearly not wrongful for those in control to exclude a thief from the “councils of power.” The court noted that the only forms of participation available to the plaintiff after his theft and discharge would be those available to a shareholder in the position of a stranger: possible entitlement to dividends, voting as a shareholder and access to corporate records. The court said that the plaintiff had no right to expect that the other corporate participants must immediately change the long-standing policy of not declaring dividends simply because he was discovered to be a thief and was discharged. The court found that the conduct complained about by the plaintiff in Gimple was not sufficient to justify dissolution of the corporation. While the New York special situations dissolution statute mentions only the remedy of dissolution, the Gimple court nevertheless found that the wording of the statute gave it the discretion to fashion an appropriate remedy in a proper case. The Gimple court concluded that while the plaintiff’s termination as an employee of the corporation was justified by his past misdeeds, the majority must still allow him to share in the corporation’s profits. The court ordered the corporation to give the plaintiff access to the corporation’s records, and to either alter the corporation’s financial structure and start paying substantial dividends or, alternatively, make a reasonable offer to buy out the plaintiff’s shares. The court phrased its order as a mandatory injunction, with dissolution being one of the potential remedies if the majority shareholders failed to comply.

Texas has had statutes on its books for many years that authorize a court to grant relief to a minority shareholder where there has been a finding of oppressive conduct on the part of a majority shareholder. Tex. Bus. Org. Code §§11.404-11.405 (Vernon’s 2011). The Texas statute does not define oppressive conduct, though it does provides significant remedies such as the appointment of a receiver or ordering that the company be liquidated. The only decision by a Texas court that granted relief to a minority shareholder in an action based on allegations of shareholder oppression by the majority shareholders is Davis v. Sheerin, 754 S.W.2d 375 (Tex.App. – Houston [1 Dist.] 1988). In Sheerin, the plaintiff-minority shareholder brought suit against the majority shareholders based on, among other things, the majority’s fraudulent contention that the minority shareholder had gifted his stock to them despite corporate records and other proof to the contrary, and further based on undisputed evidence that the majority sought to withhold dividends to shareholders and instead distributed all surplus funds as bonuses to the officers of the corporation. The court discussed decisions from other jurisdictions that found oppressive conduct to exist in situations similar to those described in the Gimple case, i.e. where either (1) the majority’s conduct substantially defeats the reasonable expectations of the minority shareholder; or, (2) there was “oppressive conduct,” defined as “burdensome, harsh and wrongful conduct” by the majority shareholders. Id. at 381-382. The court in Davis v. Sheerin concluded that under their general equity power, a Texas court may order a buy-out of a minority shareholder’s stock where the court concludes that there has been oppressive conduct by the majority shareholder, that such conduct will continue to occur and that a less harsh remedy would be inadequate to protect the rights of the minority shareholder. Id. at 380. The court was essentially recognizing a separate cause of action in equity for shareholder oppression and using its equitable power to craft relief that was distinct from the limited remedies available under the Texas statute mentioned earlier.

Litle v. Waters, 1992 Del. Ch. LEXIS 25 (Del. Ch. Feb. 10, 1992), is the only Delaware case that could be found that recognizes a tort cause of action for shareholder oppression. In Litle, the majority shareholder and an officer he controlled were the directors of a subchapter S corporation that had been very profitable and flush with cash for years. The minority shareholder sued the directors for their continued failure to declare dividends while they consistently approved the paying down of investment debt to the majority shareholder, thus providing the majority shareholder with a source of cash to pay his share of the sub-S pass-through income tax liability but leaving the minority shareholder to suffer an oppressive tax burden: sub-S pass-through income liability with no corresponding dividends or other payments from the corporation to pay the minority shareholder’s pass-through tax liabilty. The plaintiff minority shareholder alleged that the defendants refused to pay dividends in order to place a severe tax burden on him so that he would be squeezed out of the company, enabling the majority shareholder to buy him out for less than fair value. The director defendants brought a motion to dismiss the minority shareholder’s case, including the shareholder oppression claim, arguing that the declaration and payment of a dividend is in the discretion of the corporation’s board of directors in the exercise of its business judgment. Relying upon decisions from other jurisdictions, particularly Gimpel v. Bolstein, N.Y. Supr., 477 N.Y.S.2d 1014, at 1018 (1984), the court in Litle approved standards for a finding of oppressive conduct, concluding that a minority shareholder has adequately stated a claim of shareholder oppression where he alleges acts that satisfy either the “reasonable expectations of the minority” test, or the “burdensome, harsh and wrongful conduct” test as described in Gimple. The court found that the plaintiff satisfied his burden of stating a claim for “fraudulent, oppressive or gross abuse of discretion” and denied the defendants’ motion to dismiss.

There is no distinct tort cause of action for shareholder oppression in California. Such claims in California are brought by minority shareholders as claims for breach of the controlling shareholders’ fiduciary duty to the minority. However, there are limited situations where the remedy of involuntary dissolution of the corporation is available for the protection of shareholders in California, as will now be discussed.

Bauer v. Bauer (1996) 46 Cal.App.4th 1106 [54 Cal.Rptr.2d 377] is the leading California case interpreting the two prongs of the involuntary dissolution statute that seem particularly designed for the protection of oppressed minority shareholders of non-public corporations. In Bauer, the mom and pop founders of West Coast, a company that installed and maintained vending machines, had transferred ownership of the business to their three sons, Bruce, David and Wayne, to carry it on and to provide the sons with employment. The company did not hold annual shareholder meetings and did not pay dividends. Bruce was the controlling stockholder and under his operational control the company had been successful and profitable for a long period of years. Then, at Wayne’s request he was placed in charge of the company and the business had substantial losses during the approximately two year period it was under his operational control. A shareholders meeting was called, Bruce was reelected to the board but Wayne and David chose not to seek reelection as directors, instead voting their shares for their father, Kenneth. A third director from outside the family was also elected. Bruce resumed operational control of West Coast, although Wayne and David remained as officers and employees. Wayne and David then set up a competing business, Heritage Vending, and began to solicit West Coast’s customers and Wayne also took over operational control of another business owned by the three brothers, Food Tree Snack Bars, which he used as a source of interim support and to fund his competing business. Months later, the board of West Coast voted to terminate David and Wayne as employees of the company on the grounds that they had disrupted its business, solicited its customers and used its proprietary information in the creation of the competing business. David, Wayne and Kenneth then brought suit seeking involuntary dissolution of West Coast under subsections (b)(4) and (b)(5) of sec. 1800 of the Corporations Code.

Subsec. (b)(4) of California’s involuntary dissolution statute authorizes a court to dissolve a corporation where those in control have been guilty of “persistent and pervasive fraud, mismanagement, or abuse of authority or persistent unfairness toward any shareholders.” In Bauer the plaintiffs argued that the term “persistent unfairness” should be interpreted in accord with the minority shareholders’ “reasonable expectations” and that they were “squeezed out” by Bruce’s actions because they were excluded from any economic benefits of ownership of their stock. The appellate court in Bauer rejected this contention, relying upon an earlier California decision, Buss v. J.O. Martin Co. (1966) 241 Cal.App.2d 123, 134-137, in concluding that the term “persistent unfairness” in the statute aims at the misconduct of the dominant stockholder’s mismanagement of the corporation to the financial loss of minority shareholders, and not at the “reasonable expectations” of the minority. The Bauer appellate court observed that Bruce’s termination of Wayne’s employment was for the legitimate reason of protecting the corporation from Wayne’s efforts to take away its business.

Subsec. (b)(5) of California’s involuntary dissolution statute permits a court to dissolve a corporation owned by 35 or fewer shareholders where dissolution is “reasonably necessary for the protection of the rights or interests of the complaining shareholder or shareholders.” In Bauer, the plaintiffs argued that this much broader standard in the statute required the trial court to focus on whether the plaintiffs required protection as minority shareholders and to ignore any misconduct of the parties. The plaintiffs argued that dissolution was required after proof that Bruce terminated Wayne’s employment at West Coast and after that time Wayne received no dividends or other benefits for ownership of his interest in the corporation. The appellate court in Bauer also rejected this contention, this time relying upon another earlier California decision, Stumpf v. C.E. Stumpf & Sons, Inc. (1975) 47 Cal.App.3d 230, which held that under this relatively liberal provision, which is discretionary, a minority shareholder must persuade the court that fairness requires the drastic remedy of involuntary dissolution under the circumstances of the case before it. The Bauer appellate court found no abuse of discretion by the trial court in denying dissolution of West Coast under subsec. (b)(5) of the statute, reasoning that Wayne and Kenneth could not have had a reasonable expectation of lifetime employment at West Coast while at the same time they were going into competition with the company and soliciting away its customers. Subsection (b)(5), the court declared, was not intended to be used coercively to force an involuntary dissolution by shareholders acting in bad faith. The appellate court in Bauer upheld the trial court’s denial of the remedy of involuntary dissolution under either of the prongs of the statute urged by plaintiffs, finding that the plaintiffs failed to show “persistent unfairness” or that they were improperly squeezed out of the corporation and that involuntary dissolution and liquidation of the corporation was not reasonably necessary to protect plaintiffs’ rights and interests.

Is there a shareholder oppression remedy in California? The courts in California do not recognize a separate tort cause of action for shareholder oppression, however shareholders in California have a number of remedies when they are oppressed by majority shareholders in private corporations. A minority shareholder can bring a tort cause of action against a majority shareholder for breach of fiduciary duty where the majority shareholder has abused the power to control the corporation to benefit himself and to the detriment of the minority shareholders. Minority shareholders in California can also seek involuntary dissolution of the corporation for “persistent unfairness” by “those in control of the corporation” under the provisions of a remedial statute. Finally, under the same remedial statute, in the case of corporations in California with 35 or fewer shareholders, a shareholder can seek involuntary dissolution of the corporation without any showing of fault where “liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder or shareholders.”